A Look Back at 2011 and Positioning for 2012

We need, in prep for next week, to get the new high list to learn from it. We also need to do the best stocks in the Dow and take a look at the top performers in the S&P and Nasdaq for our playoff series…

Comments below. I am playing it strictly by the book for analysis looking at the best S&P and the best Nazz

This week on Mad Money, we have been combing through the best performers of 2011 in a ‘Superbowl competition’ of the stocks that locked in the most upside in the S&P and Nasdaq.

So who cares? Isn’t 2011 behind us? Well, yes. But identifying what has worked in the past twelve months can be one important tool used to best position yourself as an investor going into 2012. Why? Because, as much as we like to think (for the sake of New Year’s resolutions) that January 1st welcomes in a complete new leaf and fresh beginning, the calendar shift is ultimately psychological (with all due respect to the Mayans!) and won’t instantly trigger major rotations into new sectors. And thinking about what sectors are going to work next year is key—because, after all, a great deal of a stock’s move does depend on its sector—to some degree due to the “ETF-ization” of stocks, as Jim discussed on Tuesday.

In addition, the defensively postured sectors that were the best performers in 2011—the utilities, consumer staples, and healthcare groups—continue to be well-situated in the current environment given continued macro uncertainty in Europe. (It’s notable, too, that the best performers of the Dow were also defensively postured names—McDonald’s , IBM , and Pfizer. Plus, as Adam Parker of Morgan Stanley pointed out in his strategic outlook note on Tuesday, the market continues to reward dividend yielders … Not to mention that over the past century, over 40 percent of the S&P total return has come from dividends (data courtesy of Wharton wizard Jeremy Siegel). With cash balances at record highs (over $1.4 trillion in net cash on the balance sheets of the largest 1500 US companies), there are many opportunities to seek returns in companies that are returning this cash to shareholders via dividend payments—particularly at a time when treasuries are yielding less than 2 percent.

However, this approach should not suggest that you should blindly buy the top names in the utilities, consumer staples and healthcare, where the sectors were up 14.8 percent, 10.8 percent, and 10.1 percent, respectively, in 2011. This strategy is misguided for the following three important reasons, with some key stock takeaways:

(1) While dividend yields do offer some downside protection, they are less attractive the higher a stock moves. Particularly when it comes to ‘accidentally high yielders’ –names whose dividend yield has surpassed 4 percent because the stock has not performed well—there is less downside protection after the stock runs up and the yield, consequently, comes down. The attractive yield and valuation of AT&T is one of the reasons we highlighted it over Verizon on Tuesday’s show for example.

(2) When it comes to ‘value names’ with slower growth—many of the consumer staples names come to mind like General Mills , Kellogg, and Heinz —it is key to be wary of their valuation and upside caps on that valuation. These are not names with the earnings momentum we see in the likes of Intuitive Surgical or Cabot Oil & Gas that we highlighted on Tuesday. Because of that, many are range bound and should not be held onto without acknowledgement of their moves.

Take Heinz for example. After Jim bought the stock for his charitable trust on Sep 23rd (the stock closed that day at $49.74), he sold out of the position on November 15th (the stock closed that day at $53.78, or up 8 percent). While the stock remains an attractive long-term play on emerging market growth and innovation, its run alone along with high commodity costs represent a cap on much additional upside from current valuation levels … And it would instead be a name to come back to on a pullback. On the other hand, Kellogg, down 1 percent last year (underperforming its peers and far-underperforming Heinz up 9 percent) offers an interesting entry point for a trade, even though it’s not as well-run of a company with continued pains from its turnaround efforts (we were thrown for a ‘fruit loop’ last quarter, as Deutsche Bank outlined).

(3) Individual stock picking and relative valuation do still live … and examining the value propositions of different names in the same sector is more important than ever. For example, while Bristol-Myers has demonstrated its best-of-class status among the major pharmas, it was up 33 percent in 2011. Johnson & Johnson on the other hand was up only 6 percent and currently carries a considerably lower P/E multiple to boot. The latter is worth looking at based on its relative underperformance, particularly given many of the consumer division overhangs are in the past and a number of pipeline developments remain ahead.

The bottom line: Expectations and valuation play an important role when it comes to dividend names—along with yield. The defensively postured names should continue to make up a significant portion of your portfolio as we enter 2012 … but don’t lose sight of the importance of selectivity … and of not overstaying your welcome in a name.